Why Canada’s wealth management sector is ripe for disruption

Last week I participated as a panellist at an AIMA Canada Investor Forum titled “Investing in an Age of Disruption.” Being a direct industry participant and co-founder of an investment firm, the topic is one that I believe deserves a lot of attention, especially from Canadian investors.

While Canada has had its share of financial innovation, the oligopolistic structure of the industry has in the past inhibited that innovation from disrupting the status quo in a positive manner. It has failed to do so because 90 per cent of Canadian investors choose to have their wealth managed by the Big Five banks, as compared to American investors who prefer to deal with independent Registered Investment Advisors (RIAs), with only 35 per cent dealing with the five biggest U.S. banks.

A great example of this is the exchange traded fund (ETF) market which has exploded in popularity globally. Many may not realize that the world’s first ETF — Toronto 35 Index Participation units (TIPs) — was created by the Toronto Stock Exchange in March 1990.

Now consider the following: Bank of Montreal, which was the first major Canadian bank to launch an ETF business, did not do so until 2009, 19 years after TIPs. BMO was followed by RBC Global Asset Management in 2011, while TD Asset Management re-entered in 2016 following a brief stint in 2001. The Bank of Nova Scotia, CIBC and National Bank have only just this year launched their own ETFs.

The banks historically have had a golden goose — in the form of high-fee in-house mutual funds — which was protected by their impressive control over what their clients could see and invest in. As a result, the banks were strongly disincentivized from introducing lower fee and easily tradable ETFs, until Canadian investors demanded access. The situation is not unlike how our telecommunication and wireless carriers had locked their phones with high-cost, three- and five-year cellular plans until consumers finally started pushing back.

Meanwhile, ETFs have disrupted Canada’s largest independent investment managers, who have experienced massive margin compression on higher compliance costs and much lower fees. The banks, being more protected via their control over Canada’s distribution channels, ironically are now using the disruption in the industry to increase their market share by consolidating the independents.

We have seen this phenomenon accelerate with TD’s acquisition of Greystone Managed Investments and BNS’s acquisition of Jarislowsky Fraser, and MD Financial Management. More recently, Calgary-based Mawer announced it has hired Scotiabank to explore options, including a sale.

Now all of these firms are essentially investment product manufacturers so it makes a lot of sense for the banks to consolidate them into their Borg-like, “you will be assimilated” structures. However, we are keeping a very close eye on whether this distribution system will be disrupted itself, with Canadian investors finally giving the independent RIA model — which has been successful south of the border — a try.

Frankly, the problem is that Canadians currently do not have a lot of alternatives with a plethora of smaller independents all competing against each other for that 10 per cent slice of the market, with many still focusing on the old model of creating investment products and “tapping” into the bank-owned “distribution” system.

In our opinion, there is a great first-mover advantage to be had for an independent player willing to scale up by consolidating these independents and focus on the direct-to-client relationship model. We know of one U.S. consolidator quite active in the Canadian market and some larger innovative independents trying to get more market share, but we have yet to see a real tide of change — at least not yet anyway.

Martin Pelletier, CFA is a Portfolio Manager and OCIO at Tri Vest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.